John R. Moran on strategy and innovation

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For a long time, the answer has been “more.” Ever since Frederick W. Taylor did time studies of steelworkers with a stopwatch in 1900, the measurement of business activity – called “Greater Taylorism” by Walter Keichel in his business history “The Lords of Strategy” – has grown ever more central to management. One result of this drive to quantify and analyze has been that senior executives often create numerous profit centers, or isolated groupings of both revenues and expenses nested within large businesses.

The two benefits are obvious. First, profit centers allow these executives to make better decisions. In organizations whose various revenue and cost accounts are not linked, poor economic performance can be hidden by positive results elsewhere, and decision-making is clouded. Second, profit centers help make accountability clear. By giving managers direct profit and loss responsibility, companies can incentivize activity that measurably contributes to the bottom line.

So in most large companies, different business divisions and geographic regions are organized as distinct profit centers. Increasingly, product lines, key customer accounts, or brands are treated as mini-businesses as well, like at Procter & Gamble, where global brand managers have P&L responsibility. For that matter, why not functions too? Some organizations are establishing transfer prices for supplies and services between business departments (such as manufacturing and sales), and then measuring, and rewarding based on, the income of each.

There’s just one problem. We optimize what we measure. And the entire logic of profit centers rests on the assumption that maximizing the pieces will maximize the whole.

Unfortunately, this shortcut often isn’t true. Exceptional, sustainable results derive from great strategy, and great strategy isn’t additive – it relies on the way individual pieces fit together in a system, so that the whole is greater than the sum of the parts.

Decision scientists know this – in their models, it’s the difference between finding the local optima (the best result within each “neighborhood”) and the “global optimum” of the whole system. For that matter, football coaches know it too; no professional coach would argue that the best way to win a championship is to focus on maximizing each individual player’s performance statistics.

Yet this is exactly how many businesses are run. Rather than sacrificing certain parts for the good of the whole, companies essentially force each division to stand on its own. This approach undermines strategic fit, which, as Michael Porter put it, “requires the integration of decisions and actions across many independent subunits.”

For a coherent strategy to work, then, the organization executing it must be measured as a whole, rather than as parts. In other words, if a company is to have a single strategy, it must be driven by a single P&L.

This may sound like an extreme position. Yet some of the world’s most successful companies operate this way. Apple famously has only one P&L, for which its CFO, Peter Oppenheimer, has direct responsibility. And while each of its major hardware product lines is priced to make a significant profit, it bundles in all its key software upgrades, products, services, and platforms for free. CEO Tim Cook explains the logic:

“We manage the company at the top and just have one P&L, and don’t worry about the iCloud team making money and the Siri team making money. We want to have a great customer experience, and we think measuring all these things at that level would never achieve such a thing.”

It’s Apple’s single-company mindset that lets it give away industry-leading software and cannibalize its own products, which in turn has led to its unprecedented success. But that’s not to say a single P&L is always the right answer. Instead, a company should have as many P&Ls as it does distinct strategies. P&G’s Gillette shaving brand has a very different strategy from its Bounty paper towel brand, and Gillette has a different strategy in India than in North America. But although Gillette sells its razors and blade cartridges separately, these products fall under a single strategy. P&G’s profit centers reflect these boundaries.

Of course, companies should still measure a division, product, or function’s profitability (to the extent it can be done accurately) – that’s just good management. But this shouldn’t be the primary basis upon which managers are held accountable for their decisions, or they won’t enact a strategy that looks beyond their narrow interests. Amazon wouldn’t be able to underprice and over-market the Kindle to achieve their larger strategic objective of selling content if the Kindle product manager’s main objective was to maximize hardware profits. Nor would “free” look like such a great price point for Google’s Android unit.

So measure carefully – because if you reward each area of your business for acting in its own best interest, you just might get what you wish for.

On the surface, Gillette looks like a model of innovation success. A flagship brand of innovation champ P&G, Gillette’s achieved a remarkable ~70% share of the global men’s razor market, all while maintaining huge margins. The secret to getting so many men to pay so much is a series of new-and-improved razors that – despite making Gillette the butt of endless jokes – has carefully targeted areas of consumer dissatisfaction. Last year’s new Fusion ProGlide was a perfect example: it built on a key insight – men get post-shave irritation due to facial hair “tug and pull” – by using finer blades to slice through tough beard hair more effortlessly. Despite blade cartridges retailing for roughly $4 each, ProGlide sales since launching last summer – backed by a massive marketing campaign – were some of Gillette’s best ever for a new product. They’ve followed their innovation playbook for so long that it looks easy: a great business model + big market research + big R&D + big marketing = huge profits.

An unknown but presumably large number of “overserved” consumers and untapped nonconsumers (those who don’t shave frequently – or at all – because of cost or inconvenience)

The theory’s prediction is clear: some entrant will develop a less effective but simpler and/or cheaper solution to hair removal. It may initially capture only a small – and relatively less profitable – portion of the bottom of the market, but will likely improve its technology over time and relentlessly advance up-market. Gillette would find itself in the innovator’s dilemma, choosing (rationally) to cede less profitable business at the market’s low end and retreat to ever-higher ground, ultimately ending up with only a niche specialty market, if it’s not forced to exit altogether. If a fall from such a lofty position as Gillette’s sounds unlikely, consider the fate of Bethlehem Steel in the 1980s, IBM in the 1990s, Kodak in the 2000s, and, most recently, HP.

Reversing the Process

Fortunately, there are ways to escape this trap. In one prominent 2009 article, Tuck professors Vijay Govindarajan and Chris Trimble, along with CEO Jeff Immelt, described GE’s plan to disrupt itself via “reverse innovation.” Rather than develop products for the affluent U.S. market and try to sell them in the developing world, GE’s business units have begun to develop products specifically for the mass Chinese and Indian markets, such as a portable ultrasound device with lower quality and fewer features – but a price tag 80% below a conventional one. To pull this off, the key for GE was, as the authors put it, “shifting the center of gravity” to the overserved emerging market – in customer research, R&D, and organizational decision-making. Even more remarkably, GE has advanced its low-end technology to the point where a version can be sold competitively in the developed world, completing the reverse innovation cycle. GE Healthcare’s PC-based ultrasounds, for example, were developed for rural China but have been introduced into the U.S., where they may have cannibalized sales of GE’s traditional machines – but have also disrupted competitors, as well as preempted other potential developing-world entrants.

P&G isn’t stupid either. Since Gillette was acquired by the global conglomerate in 2005, its approach to market research and product development has been slowly but dramatically transformed. The razor business’s far less visible but perhaps more important 2010 product launch was the Gillette Guard, its first razor developed entirely in and for the Indian and other emerging markets. Through thousands of hours of in-person study, Gillette researchers learned that Indian men primarily sought a safe razor that could be easily rinsed in a bowl of still water, and that was cheap enough to be a reasonable alternative to a barber – or to not shaving at all. The Guard was developed (from a “clean sheet” design) with a safety comb, easy-to-rinse blade cartridges, and a single blade in a plastic housing with 80% fewer parts. Compared with the ProGlide, this simple design likely yields a relatively worse shaving experience by American standards, but the Guard’s replacement blades cost a mere 5 rupees – 95% less than the Indian version of Gillette’s Mach3.

Disrupt or Be Disrupted

But does Gillette’s emerging-market razor solve its innovator’s dilemma? For one thing, Gillette has shown no interest in importing even an improved version of its ultra-cheap, “good enough” product back to the U.S. It’s perfectly reasonable to point out that, in the developed world, Gillette’s share is so dominant (and margins so huge) that the cost of cannibalizing its sales of premium razors would be much higher than GE’s. Competitors won’t care, however, which is why Govindarajan argues that, unless it is willing to risk much of its core business itself, someone else will eventually do it for them. And lest Gillette think it can wait until it spies a potential disruptor before developing a U.S. version, it might do well to remember the lessons of Seagate, which developed its own 3.5″ computer hard drive but ignored its unattractive business case relative to its core 5.25s – only to be disrupted by Conner Peripherals, a former Seagate spinoff which focused on 3.5″ drives and rapidly left Seagate behind. As Christensen put it,

“[W]hen established firms wait until a new technology has become commercially mature in its new applications and launch their own version of the technology only in response to an attack on their home markets, the fear of cannibalization can become a self-fulfilling prophecy.”

A deeper question is whether a redesigned low-end razor is really what will ultimately disrupt this market. After all, a durable handle with disposable snap-on blades, scraped across a lathered face every day, is a rather clumsy solution to the job of hair removal (especially when defined broadly). The Gillette Guard made a radical trade-off in relative performance and price attributes, but didn’t fundamentally change Gillette’s model, entrenched as it is by decades of pervasive marketing. It’s easy to imagine how a chemist might develop a cheap cream that stops hair growth entirely, but has some negative side effects or other factors that cause traditional shaving consumers – and therefore Gillette – to ignore it. Until, that is, the kinks begin to be ironed out, and its inexorable march up-market causes Gillette to flee rather than fight.

By then it will be too late. The key question, therefore, is whether Gillette has the courage to truly disrupt its own seemingly invincible core business. If not, disruption will eventually come from without. It’s just a matter of when.

My friend Dave is a great guy, but terrible to go to restaurants with. Invariably, he ends up peppering the server with endless questions, trying to order things not on the menu, and complaining about the food once it’s served.

People like Dave may be hard to dine with, but they can be great for innovation. That’s because they’re continually dissatisfied with what’s available, looking instead for an ideal experience. The best innovators utilize several techniques to understand consumer dissatisfaction – and then use that understanding to drive innovative ideas.

Listen to problems, not solutions

Recently, many have cited Henry Ford (who famously quipped, “If I had asked people what they wanted, they would have said faster horses”) and Steve Jobs (“You can’t just ask customers what they want and then try to give that to them”) to make the case that listening to customer feedback is pointless. But as Ted Levitt, Tony Ulwick, and others have argued, while customers are notoriously bad at coming up with solutions to their own problems, their actual difficulties and complaints – the problems themselves – are a goldmine for observant researchers. That’s why management gurus like Clay Christensen and Gary Hamel have advocated listening not only to your core (and presumably satisfied) customers, but to those on the fringe – the unhappy non-users and complainers. And the louder they whine, the better.

Map out dissatisfaction

To better understand consumer dissatisfaction, author and consultant Adrian Slywotzky has advocated creating a “hassle map” – laying out the entire customer experience with a product or service to pinpoint where customers become frustrated by wasted time and effort. Far too many companies focus solely on adding exciting features to the product itself; great innovators instead often aim to eliminate irritating aspects of the experience. For example, Apple’s most successful products have often reduced hassle in the customer experience as much as they’ve added new capabilities. Through Visual Voicemail, the iPhone improved the bothersome process of navigating phone messages. The iPad greatly reduced both lengthy computer start-up time and the painful need to frequently recharge (through its hugely extended battery life). Most recently, the iCloud service aims to eliminate the irritating need to sync Apple devices using cords. Contrast these improvements with those of other PC-makers in recent years, who focused on adding security features, hundreds of gigs of storage, cameras, etc.

Imagine the ideal

P&G’s consumer researchers have been known to put on “futurist exhibits” to help spur innovative product concepts. After extensive consumer observation and discussion, researchers mock up nonworking but clever products in answer to the question: “How might consumers solve this problem in 50 years?” For example, rather than using an imperfect product that P&G offers today, perhaps the consumer of the future will simply swallow a pill annually to prevent hair from going gray, press a button to have house walls suck away dirt, or drink a tasty beverage to automatically clean his or her teeth. While these Jetson-like inventions may seem far-fetched, the brilliance of the “in the future” conceit is that it allows P&G innovators to forget today’s technical limitations and instead imagine what a perfectly simple and effective solution could look like. Who doesn’t like to imagine a frustration-free future?

Through these and other methods, companies can use consumer dissatisfaction to drive better innovation. A twist on the old maxim is appropriate: Don’t let today’s ‘good enough’ be the enemy of ‘better yet…’ And if you learn to love customer dissatisfaction, you may even be able to put up with a whiner like Dave.